A new UAE Bankruptcy Law, (Federal Decree Law No. 9/2016) was published on 29 September 2016 and came into force on 29 December 2016. Its aims are to modernize and streamline the bankruptcy procedures which are available onshore for UAE companies in line with international best practice and destigmatize business failure whilst maintaining accountability for directors of failed enterprises. Consistent with other areas of UAE legislation, the Emirates’ bankruptcy laws have historically been influenced by French civil law traditions. Federal Decree Law No. 9/2016 has not tried to abandon those principles, but it has also incorporated modern French law mechanics, and best practice concepts found in German, English and US insolvency legislation. Application and scope Federal Decree Law No. 9/2016 apply to companies which established according to the UAE Commercial Companies Law (Federal Law No. 2/2015), corporate entities and individuals trading for profit (such as lawyers and accountants). However, there are certain key exceptions including governmental bodies and companies incorporate within free zones (such as the DIFC and ADGM) which have their own comprehensive insolvency laws which provide for composition, restructuring or bankruptcy procedures. Entities which are wholly or partially owned by the local or Federal government and are not established according to Federal Law No. 2/2015 may wish to opt into Federal Decree Law No. 9/2016 in line with their constitutional documents. In the UAE there are also a number of commercial enterprises establishing as decree companies, whose levels of government holdings vary from being direct to indirect or ultimate beneficial ownership stakes. UAE legislation does not generally provide an unambiguous definition of a ‘government entity’ so it is unclear if decree-formed commercial companies which are indirectly holding through government-owned investment
Companies exempt from this law without a specific opt-in. Further legislation is expecting in the near to medium term regarding insolvent financial institutions and other regulated enterprises such as insurance companies. However, Federal Decree Law No. 9/2016 states that the Financial Restructuring Committee (FRC) also has the authority to oversee financial restructuring procedures involving regulated financial institutions.
Federal Decree Law No. 9/2016 established a Financial Restructuring Committee (FRC), which is responsible for monitoring the implementation of the new law and reporting back to the Minister of Finance. The aim of establishing the FRC was clearly to ensure there was a commercial, modern and industry-focused approach to restructuring. The FRC will be responsible for selecting a roll of industry experts (insolvency professionals potentially from private practice) to help the courts with the new insolvency and restructuring procedures. It is also responsible for setting up the relevant public registers and for capturing details of insolvent companies and disqualified directors.
Crucially, the criteria for determining when a company is insolvent have been clarified. The cash flow test for insolvency has refined and a balance sheet insolvency test has been introduced (which is based on the German ‘over-indebtedness’ test, whereby a debtor’s assets do not cover its current liabilities). The aim of this is to encourage debtors in distress to seek to restructure at an early stage.
Federal Decree Law No. 9/2016 also offers two court procedures, firstly, a court-based debtor-led composition process which must be using by a company which is in financial difficulties but is not yet technically insolvent; and secondly a formal bankruptcy, which itself comprises a rescue procedure within bankruptcy or liquidation.
PROTECTIVE COMPOSITION PROCEDURE (PCP)
This procedure follows the French ‘sauvegarde’ model, where a debtor which is experiencing financial difficulties but is not yet insolvent or who has been in a state of over-indebtedness or has ceased making payments for less than 30 consecutive business days, proposes a compromise with its creditors. PCP cannot apply for if the debtor has already been subject to a PCP procedure in the past year, or the debtor has already entered bankruptcy proceedings. A PCP application can only make by the debtor or order by the court and it cannot make by creditors. A shareholders’ resolution approving the application must also submit to the court. Once the debtor has applied for a PCP and submitted the necessary documents, a court-appointed expert will prepare a report on the debtor’s financial condition, determining if the conditions for a PCP have met and if the debtor has sufficient funds to cover the costs of the PCP process. If the court accepts the application, a moratorium on creditor action immediately applies. The court places the debtor under the control of one or more officeholders appointed from the FRC’s roll of experts, for an initial observation period of up to three months (which can further extend with FRC permission). However, the moratorium does not prevent the enforcement of secured claims which can still occur with the court’s permission. Entry into the PCP process is then making public, and creditors are invited to submit proofs of claim for the purposes of voting on a compromise by a claims bar date. During a PCP, the debtor continues to manage its business, albeit under the supervision of the officeholder. The officeholder has wide powers on the preservation of assets and the continuation (or otherwise) of the debtor’s business, which could invoke if required.
The debtor is getting time to devise a restructuring plan under the supervision of the officeholder. Federal Decree Law No. 9/2016 requires the restructuring plan to cover certain features, including that the duration of the plan cannot exceed three years (unless the requisite majority of creditors agree to an extension). After reviewing the plan by the court, the permission will be granting to convene creditors’ meetings, the plan is then voted on by the creditors. In order for a plan to have approval, a majority representing at least two-thirds in value of each class of creditor must vote in favor of it. If the required majorities and the court approve the plan, the dissenting minority of creditors (whether they voted or not) are still binding by it. Therefore, it is not possible for one voting class to ‘cram down’ another. Other key tools of the PCP build on useful features found in US bankruptcy law:
- It is possible to raise debtor-in-possession (DIP)-style priority funding in order to allow the business to continue during the PCP process.
- ‘Ipso facto’ provisions prevent counterparties from using insolvency-linked contractual termination provisions, provided the debtor performs its executory obligations; and
- A supervisory creditor committee nominating by the creditors is appointing and, if there are several nominations, the final choice of who takes the role is subject to a court decision. The court must take into account the level of debt each potential committee member holds or represents.
A regulator may also take a position on this committee. The role of this committee appears to be to monitor the PCP’s implementation and report progress to the court, for the benefit of the general body of creditors. No fees may charge by the committee for its role.
The UAE bankruptcy process splits into two elements:
- a rescue process within formal bankruptcy proceedings (rescue within bankruptcy), which is procedurally similar to the PCP (and includes an automatic moratorium and the ability to raise DIP funding); and
- a formal liquidation procedure.
Once bankruptcy has been applying for and the necessary documentation submitting, the next step is for a court-appointed expert to prepare a report on the debtor’s financial condition, determining if conditions are meeting for bankruptcy proceedings to begin and if the debtor has sufficient funds to cover the process costs. If the court accepts the application, a moratorium on creditor action (excluding enforcement of secured claims which may occur with permission of the Court) immediately applies and the court places the debtor under the control of one or more officeholders appointed from the FRC’s roll of experts and, if considered necessary, one or more supervisory judges. The entry into the bankruptcy process is then making public, and creditors are inviting to submit proofs of claim by a claims bar date for the purposes of voting on the restructuring. Following the start of bankruptcy, an officeholder takes over the management of the debtor’s business and receives wide powers to preserve assets and continue (or otherwise) the business. Creditors’ committees can also be forming from different creditor classes (e.g. unsecured or secured creditors) in order to review any restructuring plan and to facilitate communication with the wider creditor group. The officeholder prepares a report on the debtor’s business for the court, in consultation with the debtor. This report must state if:
- in the officeholder’s opinion there is a reasonable prospect of restructuring the debtor’s business (and, if so, confirmation from the debtor they are willing to continue their business);
- a restructuring plan should prepare for submission to the creditors; and
- if a sale of the whole or part of the debtor’s business as a going concern is likely if the debtor goes into liquidation.
Once the court satisfies with the report, it is providing to creditors for comment, before a hearing attended by the officeholder, any expert, the debtor, any creditors’ committee and the creditors. At this, hearing the court either orders the production of a restructuring plan for creditors to vote on or the debtor’s liquidation. If the court orders a restructuring plan, the procedural aspects for the PCP process (in relation to the voting/approval of the restructuring plan, the length of the ‘observation process’, DIP financing and ipso facto provisions) are also applicable to this rescue within bankruptcy process. Federal Decree Law No. 9/2016 also provides a clear framework for liquidation, should it not be possible to rescue or rehabilitate the debtor under a PCP or rescue them within bankruptcy processes.
A waterfall of priority of claims is establishing within PCP and bankruptcy, and the treatment of preferential creditors within bankruptcy (we assume to pay from the pool of funds available to unsecured creditors) is covered.
Similar to most civil law systems, the UAE Civil Code (Federal Law No. 5/1985 as amended) has historically allowed the set-off of debts. Under the old UAE bankruptcy provisions in the UAE Commercial Transactions Code (Federal Law No. 18/1993 as amended), Article 688 envisaged post-bankruptcy set-off, but only on debts which were ‘associating’ with one another. (The presumption of ‘association’ means, where the debts arose from the ‘same cause’ or the same ‘current account’. However, there was no guidance on whether the UAE Civil Code or UAE bankruptcy provisions on set-off would take precedence following a counterparty’s insolvency.
A sole set-off provision is now found in the enacted version of Article 183 of Federal Decree Law No. 9/2016, which:
- allows set-off between a creditor and debtor if it had been contractually agreed prior to insolvency, but not in respect of debts which arise after the start of an insolvency procedure (whether it is PCP or rescue within bankruptcy); and
- allows creditors to submit a claim for a ‘post set-off’ amount to the insolvent party’s estate or, if the creditor owes the insolvent party the ‘post-set-off’ sum, the creditor pays this sum to the insolvency estate.
In the absence of any further clarity on the nature of the sums which can use as part of Article 183 set-off, the provisions of the Federal Law No. 5/1985 governing ‘mandatory set-off’, namely, that ‘each of the parties must be both the obligor and the obligee of the other and the obligations must be of the same type and description, must be equally due and must be of equal strength or weakness’ would remain relevant to the legal analysis of set-off rights.
POST-INSOLVENCY NETTING FOR DERIVATIVES CONTRACTS
In the context of derivatives contracts, the post-insolvency enforceability of close-out netting is particularly significant as an effective counterparty credit risk mitigating tool. The key difference between close-out netting and set-off is that close-out netting can take place across a number of transactions, regardless of when payments would o become due (in other words, values are calculating on unperformed obligations such as future swap payments or deliveries under outstanding swap transactions, which become part of the sums applying as part of close-out netting).
In the absence of any UAE legislation providing specific recognition of close-out netting, statutory insolvency set-off can, in some respects, go part of the way to enable a similar effect to closeout netting upon counterparty insolvency. However, insolvency set-off provisions, unless combined with further provisions, do not alone provide sufficient support for a completely positive netting analysis because there remain other factors under which a lump sum close-out amount can be undermined, such as:
- Termination of contract – the first step to effecting close-out netting is to terminate all outstanding transactions, which are often contrary to the statutory requirement for contracts to continue during a period of moratorium. Whereas the PCP provisions in the Federal Decree Law No. 9/2016 include a carve-out to allow terminations required to effect Article 183 setoff, an equivalent is not expressly provided for rescue within bankruptcy procedures;
- Cherry-picking – in all of the three procedures available under Federal Decree Law No. 9/2016, the insolvent party’s officer has powers to review the sums submitted as claims on the insolvent estate. This power makes it possible for lump sum close-out amounts to picking apart across multiple transactions, so the creditor has to pay the gross amount of all or some of the ‘in the money’ transactions to the insolvency estate, while filing a claim separately for the claims under the ‘out of the money’ transactions; and
- Valuation of close-out transactions – the valuation of close-out amounts includes ascribing values to amounts which may not yet due (e.g. on unperformed obligations) such as those in market standard documents such as the ISDA Master Agreements or the ISDA/IIFM Tahawwut Master Agreements which may not recognize in every jurisdiction.
When it comes to directors, general managers and shadow directors, Federal Decree Law No. 9/2016 has retained much of the current regime on potential civil and criminal liabilities where these individuals have contributed to a company’s bankruptcy. Fraudulent conduct leading to the bankruptcy of a company (or fraudulent conduct following the entry into proceedings) can result in up to five years’ imprisonment and fines of up to one million AED. A sliding scale of punitive measures (including potential prison sentences and substantial fines) is provided for other mismanagement or wrongful conduct which the court finds has precipitated company failure and caused losses to creditors (including acts which occurred within the insolvency proceedings themselves). There can also potentially, be an obligation to contribute to the losses of the company in whole or in part if creditors make less than a 20% recovery. However, failure to file for bankruptcy within a 30-day time period no longer in itself confers criminal liability, but it can be grounds for disqualification. Federal Decree Law No. 9/2016 has also introduced a disqualification regime (similar to the one in English insolvency law) whereby directors found guilty of the bankruptcy linked offences can be disqualified from playing any role connected to company administration for up to five years and may also be subject to fines. Federal Decree Law No. 9/2016 also refers to a register of disqualified directors being compiled and held within Government. The new law also appears to confer wide powers on the court in certain circumstances to declare the bankruptcy of shareholders of a bankrupt company which is undergoing liquidation, or force those shareholders to contribute their equity or share capital towards repayment of the debts owed by the bankrupt company.
Where the court has accepted an application for the PCP or rescue within bankruptcy proceedings, Federal Decree Law No. 9/2016 states any criminal proceedings relating to the debtor’s bounced cheques will be suspended with court agreement and the relevant creditor will be included within the body of unsecured creditors which must vote on the restructuring plan. If the creditor vote is passed and the court also approves the arrangements, a stay will continue until the restructuring plan is completed according to its terms, at which time the debtor can apply to have the criminal proceedings permanently stayed or terminated.
Certain transactions (such as security granted for a pre-existing debt or disposals without sufficient consideration) which take place during the two years before the start of insolvency proceedings may declare as invalid and unwound by the court, if the relevant transaction occurred at a time when the creditor knew, or ought to have known, that the debtor was insolvent and where it can be shown the transaction has caused detriment to other creditors. The court may refuse to reverse the transaction to the extent it finds it was made in good faith and for the purpose of continuation of the debtor’s business, and that there were grounds for the debtor to believe the transaction would benefit the business. Directors and general managers may also have personal liability in connection with preferential treatment of creditors and undervalue transactions. In addition, lenders who may have colluded with a bankrupt debtor in order to obtain special treatment or inflation of amounts owed, to the detriment of other creditors, may also face imprisonment, and any such transactions will be reversed by the court.
- The expansion and modernization of the PCP and rescue within bankruptcy is an extremely welcome development. However this process is not binding the secured creditors (and security may continue to be enforced with court permission while PCP processes are ongoing), it seems unlikely these rescue procedures could use by a large corporate with secured creditors. The ability to bind secured creditors and an automatic moratorium on enforcement of security, are two attractive features in other insolvency regimes including other regional insolvency legislation such as Dubai Decree No. 57/2009 (Establishing a Tribunal to decide the Disputes Related to the Settlement of the Financial Position of Dubai World and its Subsidiaries) and the Abu Dhabi Global Market’s Insolvency Regulations which do not appear in this law.
- The inclusion of a supervisory committee of creditors to oversee and monitor the implementation of a PCP plan will be obviously welcoming by lending institutions. However, as duties owed to the general body of creditors (and the court) it remains to be seen, in practice, if larger institutional creditors (who may have the most experience in such a role) would be willing to commit to a process which may carry risk and could last up to three years without any compensation.
- Federal Decree Law No. 9/2016 does not have any private, out-of-court pre-insolvency procedure (similar to the French conciliation process) which are applicable to entities that have not yet formally entered the zone of insolvency, and which aim to achieve a consensual, private settlement between the parties. Experience from the equivalent French law conciliation shows the involvement of an official mediator can help break deadlocks and avoid more formal court proceedings. Perhaps this could be an area for further consideration in the future.
- The expansion of the insolvency test to include a balance sheet element is a positive step. However, we hope, further procedural guidance will be issuing to help companies with objectively quantifying if they are indeed in a state of cessation of payments or are balance sheet insolvent in line with Federal Decree Law No. 9/2016.
- It is not clear how contractual subordination provisions (such as those in inter-creditor agreements) would be treated by an officeholder within the processes prescribed by Federal Decree Law No. 9/2016. Given that the overall aim of the new law is modernization, it gives hope that they would be recognized, particularly where experts are engaging themselves (and who may also take the benefit of legal advice).
- Although there is a provision for statutory insolvency setoff, Federal Decree Law No. 9/2016 lacks close-out netting provisions, which could lead to further complications for counterparties undergoing an insolvency process under it.
- Federal Decree Law No. 9/2016 does not include provisions on jurisdictional and judicial recognition and cooperation, to apply in circumstances where a company incorporated in the UAE (or a trader based in the UAE) operates across borders (either internationally or within the UAE) and may therefore be subject to insolvency proceedings in more than one jurisdiction, or may have assets located outside of the UAE which creditors wish to recover. Enforcement of judgments under Federal Decree Law No. 9/2016 in other non-UAE jurisdictions is likely to face the same procedural hurdles currently encountered with all UAE court decisions. So we hope that further procedural guidance or regulation will be available in due course to clarify this point. Adoption by the UAE of the UNCITRAL Model Law on Cross-Border Insolvency could, therefore, be a natural next step that the legislators might consider.
- Some practical considerations applicable in the UAE may mean that some of the timeframes included in Federal Decree Law No. 9/2016 could be challenging for creditors to comply with, such as proving debts in a UAE court process which typically requires the production of original documentation and translations, when many loan agreements are entering in English. As a result, lenders may now want to have loan agreements translated into Arabic at the start of a transaction as standard procedure.
Another area which could cause problems is that security enforcement in the UAE can be a lengthy process. Secured creditors who may not fully collateralize will need to ensure any unsecured element of their claim is claimed for within any process within the requisite timeframes, so early engagement with the officeholder will be key.
The new UAE Bankruptcy Law will be an excellent springboard for the development of a modern, robust insolvency framework in the Emirates, but ultimately its success depends on how it is applied in practice
THE ROAD TO RESCUE & RECOVERY
It is rare for individuals or companies to enter insolvency proceedings in the UAE. There are a number of reasons for this, including the stigma attached to bankruptcy. Up until now, most commercial debt restructurings have been informal out-of-court arrangements, largely because, under the old restructuring regime, court proceedings were lengthy and expensive, and tended to result in limited levels of recovery. There is also a concern that the UAE courts lack the expertise to deal with more complex business restructurings.
However, we hope the new UAE Bankruptcy Law, Federal Decree Law No. 9/2016 will change that and we will start seeing businesses in financial difficulties engaging with their creditors and potentially trying to gain assistance from one of the procedures set out in the new law. In the short-term, however, until debtors and creditors gain confidence in the UAE courts’ ability to implement this law, it is unlikely it will result in a spate of court-led insolvency procedures.
Introducing a separate legal framework dedicated to bankruptcy, as Federal Decree Law No. 9/2016 does, is a welcomed step. The regulatory reform precipitated by the new law has the potential to significantly advance the UAE’s insolvency regime.
One more helpful development is that this new law is more specific on the types of legal entity to which it applies. “Whereas the previous legislation made a generic reference to ‘traders’, Federal Decree Law No. 9/2016 expressly extends its application to all companies established under the Commercial Companies Law, Federal Law No. 2/2015, most free zone companies (except those incorporated in free zones with their own comprehensive insolvency legislation), individuals trading for profit and licensed civil companies of a professional nature.
STRUCTURE OF THE LAW
The new law has seven main chapters. In the first, there is a clear reference to the different persons to whom the new Insolvency law applies including commercial companies established under the UAE Commercial Companies Law and in free zones, except those established in jurisdictions where special insolvency laws apply and civil professional companies. This, in itself, is a considerable development as the previous applicable texts did not include a comprehensive list of the persons they applied to. The second chapter in the law provides for the creation of a new permanent committee which is calling as the ‘Committee of Financial Reorganisation’. This committee will be forming in line with a resolution to be passed by the Council of Ministers and will take into consideration the recommendation of the Minister of Finance. The third chapter covers the composition of bankruptcy procedures. Federal Decree Law No. 9/2016 aims at providing a legal framework which insolvent debtors can consider. While the fourth chapter details procedures which organize the restructuring of a debtors’ debts through a tailored plan for their business. Such a plan, if feasible, should be prepared under Court supervision or alternatively if this is unachievable (as assessed on the case by case basis), the Court may proceed to declare the bankruptcy of a debtor and liquidate its assets to cover its liabilities.
There is a fifth chapter which covers the preparation of a creditors’ list which is handled by a court appointed insolvency practitioner. The insolvency practitioner’s responsibilities under this section further involve preparing a report on the debtor’s business, including an assessment of the possibility of restructuring the debtor’s business, and if feasible submitting a restructuring plan to the creditors. In such cases, the report should include a statement showing the debtor’s commitment to continue operating its business. The report should include an assessment of the possibility of selling the debtor’s business (fully or partially or on an as is a basis).
The sixth chapter covers various areas including applications submitted in the case of body corporates; tasks and powers of insolvency practitioners and recovery of assets by third parties and stakeholders. It also includes provisions on the possibility of obtaining new financing in the case of composition or restructuring by the debtor or the insolvency practitioner handling the matter. There are additional provisions dealing with clearing between creditors and debtors; the order to follow in case of settlement of debts and organization of priorities in the case of insolvency and bankruptcy.
Chapter seven addresses penalties and discharge procedures. A number of acts committed by debtors, creditors, liquidators, experts, directors or others are covering and penalties include jail sentences of one to five years and fines between 30,000 and 1,000,000 AED. This part of the law also deals with a reinstatement of debtors who have been declared bankrupt, the circumstances in which they can be reinstated and related exceptions.
Finally, Chapter eight covers the repeal of terms in the UAE Commercial Transactions Law and Penal Code, and any other existing terms which contradict the new law.
OTHER RELEVANT NEWS
The Commercial Companies Law, Federal Law No. 2/2015 contains a number of provisions which are relevant to insolvency and relate to directors’ liabilities and the need to call a shareholders’ meeting when losses reach certain capital levels. Although it does not deal directly with insolvency, the law relating to the Pledge of Movable Properties in Guarantee of Debt (Federal Law No. 20/2016 or New Security Law) is another piece of recent legislation which will help strengthen creditor’s legal rights. The lack of a sophisticated bankruptcy regime has cited by some commentators as a reason why small and medium-sized businesses can find it difficult to obtain bank credit in the UAE. However, the fact it has been difficult for banks to take enforceable security over a business’ movable assets has also had an impact. Federal Law No. 20/2016, has a much more practical regime for taking security over movable property (including accounts payable and intangible assets) and, for the first time, will allow security to take over future assets. Since the new Bankruptcy Law gives enhanced rights to secured creditors, Federal Law No. 20/2016 is likely to have a significant impact on insolvency proceedings.
However, it is not only laws which are currently impacting insolvency in the UAE. Following the global financial crisis, many debtors who were struggling to pay their debts simply fled the country because of the criminal sanctions for bounced cheques and bankruptcy. UAE banks realized this was damaging the economy and, in 2016 (before the issual of Federal Decree Law No. 9/2016 ) the UAE Banking Federation launched an initiative, dubbed ‘Modus Operandi’ which encourages banks not to take unilateral action against struggling debtors but instead work with them towards agreeing to a restructuring scheme. Debtors have 15 days to agree such a scheme with their creditors and a further 90 days to implement it. During this period, the banks agree not to take any court action. Although this initiative does not have the force of law, it has been successful in reducing the number of debtors fleeing the country. In the short term, it will be a helpful way to deal with struggling businesses until creditors and debtors feel comfortable with relying on the courts to implement the new Bankruptcy Law.
Up until now, Bahrain has been the only other GCC state to introduce a separate law on bankruptcy and insolvency, which it did in 1987. Other GCC countries rely on provisions spread across various commercial and company laws. However, most of the other GCC states are now considering implementing specific laws and we understand such laws are currently under drafting in Kuwait, Oman, and Saudi Arabia. According to the World Bank, Bahrain has the highest recovery percentage in insolvency of any of the GCC states which shows that updating their insolvency laws has had a positive impact on creditors’ ability to recovery debts in insolvency situations. Hopefully the new UAE Bankruptcy Law will, in time, improve the Emirates’ current 29% recovery rate.”
The previous bankruptcy regime which was in Chapter V of the Commercial Transactions Law, Federal Law No. 18/1993 did not expressly impose liability on directors for trading while insolvent. Federal Decree Law No. 9/2016 also has no such provision. However, directors can be liable to shareholders and third parties (and third-party creditors) in a number of situations under various provisions in UAE laws. For example, under the new Bankruptcy Law, if a company’s properties following bankruptcy are insufficient to pay at least 20% of its debts, a court can order some or all of the directors to pay all or part of the debts although this is only if the court believes the directors were responsible for the losses according to Federal Law No. 2/2015. The court can also compel directors to contribute payments where they have acted improperly within the two years prior to the date of the liquidation order. Although the relevant provision in the new Bankruptcy Law is similar to the previous regime, directors must remember Federal Law No. 2/2015, which replaced the old Commercial Companies Law, Federal Law No. 8/1984 has tightened certain provisions on corporate governance. For example, it is not possible for directors to exclude their liability in a company’s articles of association. Under Federal Law No. 2/2015, directors can be liable to shareholders and creditors for mismanagement. Company chairmen should also note that if a company’s losses exceed 50% of its capital, criminal liability can impose on him if the company board does not convene a shareholders’ meeting to consider the company’s liquidation. Federal Decree Law No. 9/2016 has also imposed criminal or civil liability on directors for certain activities carried out during the zone of insolvency (or two-year period before bankruptcy) such as selling assets undervalue or preferring one creditor to the detriment of others. The new Bankruptcy Law has also repealed certain provisions in the Penal Code (Federal Law No. 3/1987) dealing with crimes in bankruptcy but there are a number of new criminal offenses which could be committed by directors. Although most of these offenses involve fraud, dishonesty or deliberate acts designed to frustrate the insolvency process, there are some which do not require such obvious criminal behavior including failing to maintain adequate commercial books which reflect the company’s commercial position. There is also one change by Federal Decree Law No. 9/2016 which goes some way to removing the stigma and potential criminal liability for bankruptcy. Under the Penal Code, failing to file for a declaration of bankruptcy within 30 days of ceasing to pay debts resulted in the criminal offense of ‘negligent bankruptcy’. Although this provision used rarely, it was one part of the former regime which encouraged traders in financial difficulty to flee the country for fear of facing criminal sanctions. Federal Decree Law No. 9/2016 has repealed the relevant provision of the Penal Code so failing to file for bankruptcy is no longer a criminal offense in itself. However, there is an obligation to file for bankruptcy following non-payment of debts for more than 30 business days, but failure to do this creates a civil rather than criminal liability.
There are a number of provisions in Federal Decree Law No. 9/2016 which impact employees’ rights. For example, Article 189 of Federal Decree Law No. 9/2016 defines the unpaid end of service gratuity and wages and salary of up to three months’ wage or salary, as ‘preferential debts’ which could by insolvent employers on a priority basis ahead of amounts due to other creditors. It is not clear, however, if amounts due to employees will pay in priority to secured creditors as Article 185 of Federal Decree Law No. 9/2016 states secured creditors shall rank ahead of ordinary creditors on the proceeds of their security or guarantees. The practical effect of these legislative protections is likely to largely determine by the new law’s efficiency of application and frequency of use. The DIFC regime identifies sums owed by a company as contributions to an employee pension scheme, any end of service gratuities, remuneration for a period of four months before the winding up order or resolution, payments in lieu of notice, and accrued holiday entitlement as ‘preferential debts. The ADGM regime identifies amounts payable by way of non-discretionary salary (including agreed holiday pay) or contributions to an occupational pension scheme, for the whole or any part of the period three months before the winding-up order or resolution as ‘preferential debts’. In such cases, once these preferential debts pay in full out of the proceeds of liquidation before all other secured or unsecured debts of the relevant company.
The UAE Penal Code imposes strict criminal sanctions on non-UAE nationals who issue cheques which bounce. Federal Decree Law No. 9/2016 states criminal proceedings relating to bounced cheques issued before a protective composition or restructuring scheme have stayed, once a protective composition or restructuring scheme has been initiated. The stay of criminal proceedings applies until the protective composition or restructuring scheme completes. A bounced cheque recipient is treated the same as the debtor’s other creditors and, if the relevant debts are discharging in line with the relevant composition or scheme, criminal proceedings could drop and criminal sanctions could avoid. However, criminal sanctions will potentially still apply for any cheques which bounce after the date on which the protective composition or restructuring scheme has been initiated, or if debts relating to a bounced cheque are not discharged in line the court-approved protective composition or restructuring scheme.
Federal Decree Law No. 9/2016 does not deal with personal bankruptcy, it only relates to companies and ‘traders’ which can include individuals undertaking a trade according to the laws of the UAE. It does not relate to individuals in their personal capacity. So, for example, the provisions which suspend a creditor’s ability to take action on a bounced cheque are not available for personal cheques for rent or other payments. However, we understand the UAE government is also considering introducing a personal bankruptcy law which could contain similar procedures to those which now apply to companies and traders under the new law. Although it is worth noting that even if such a law enacts in the UAE, there could be problems, largely because most debtors in the Emirates are expats, and it would be easy for them to return to their home country and start again without any of the consequences associated with being a bankrupt under UAE law. Without being able to ensure a bankrupt individual also becomes a bankrupt in his home jurisdiction (which would require co-operation with other countries), it is hard to see how a personal bankruptcy law would work in the UAE. At present, UAE commerce and banking relies heavily on the criminalization of bounced cheques and any change to this position would potentially have far-reaching consequences.”
The fallout from the global financial crisis helped sharpened the focus on the options available to financially distressed or insolvent companies and their creditors under applicable UAE insolvency regimes. Given past uncertainty on the application of existing legal frameworks and concerns about their efficiency, financially troubled corporate entities and their creditors in the UAE have typically had little option other than pursuing a consensual, negotiated settlement or reorganization, and where this has not been possible stalemate has ensued.
Federal Decree Law No. 9/2016 is trying to establish a modern insolvency framework which more closely aligns with international best practice, but until the business community satisfies the new law is being implemented in a certain, transparent and consistent way companies and their creditors are likely to continue to seek, consensual out-of-court reorganizations before turning to formal legal mechanisms. In order for Federal Decree Law No. 9/2016 to enforce successfully, it will require the implementation of transparent and comprehensive policies on the level of commercial companies particularly with respect to the preparation of financial statements and disclosures. For example, the relationship between companies and auditors in the UAE at present is largely unsupervised, and all parties would benefit from clarifying and monitoring the methods and parameters used by auditors to prepare their reports. Auditors may also have a direct role to play in raising awareness and emphasizing the importance of this law to their clients.
Heavy reliance on the local court systems and court-appointed experts means that it will also be vital to implement good support structures and training for the judiciary. However, this law does represent a move towards a more flexible and internationally-aligned approach which should help UAE businesses work through financial difficulties and, where possible, avoid liquidation.
One of the issues faced under the previous insolvency regime was due to a lack of industry expertise on the part of the court-appointed experts. We believe it was a fundamental obstacle to its success. Hopefully, the courts will appreciate that for the new bankruptcy law to successfully implemented cases will have to match to suitably experienced experts. The role of these experts, who will mainly be appointing as insolvency practitioners, has been widely covering in the new law and it will be important to have those with the necessary qualifications and with the ability to understand the UAE’s sophisticated commercial environment on board.
Streamlining the professional methods and standards to which UAE liquidators have to adhere would also contribute to a more efficient insolvency procedure.
At present UAE liquidation procedures tend to be extremely time-consuming and costly, and often also detrimentally impact recovery rates. The efficient handling of the liquidation of assets and pending legal claims is essential in securing third parties and creditors’ rights. A structure must be in place which can ensure the proper supervision of liquidators and there must be valid restrictions on the extent of their powers. This would help maximise liquidation outcomes and reduce any exposure to unnecessary financial expenses during the process. The last important feature in ensuring that this new law will help advance the UAE’s bankruptcy regime will mainly depend on local courts’ interpretation and implementation of its provisions and new features.
It will also be necessary to maintain and track homogeneous precedents which can support a uniform interpretation of the law’s provisions.
We hope however the regulations which issue in connection with this law and the creation of the Committee of Financial Reorganisation will pave the way towards the creation of a successful and comprehensive commercial insolvency regime in the UAE.